6 smart ways to use a home equity loan to consolidate debt

Chances are, you've poured a whole lot of care, attention, and money into your home. The home is often a family’s largest asset.

It’s also one of the most effective ways to build wealth, because of home equity (the difference between how much your home is worth and how much you owe). Building home equity means you could be sitting on a small fortune. Your home equity may be money you could use to rid yourself of high-interest debt, simplify your life, save money, and improve your credit standing. 

Here are six smart ways a home equity loan could help you make the most of the value you've built into your home. 

1. Lower your monthly debt payments

If you have a couple of balances you’re paying off, here’s what $20,000 in debt might look like:

• Credit card with 23% interest: $12,000 

• Financing a hot tub at 18% interest: $8,000 

• Total monthly payments: $639

Your budget feels tight, and at this rate, it's going to take three years to finish paying for the hot tub and nearly five years (57 months) to get rid of the credit card debt.

Let’s say you turn to a home equity line of credit (HELOC) instead to repay the $20,000. You can afford your payments, but you’d like to shave off $100 a month if you can.

• HELOC interest rate: 12%

• Time to pay off balance: 48 months

• Monthly payment: $527

Not only do you shave some time off debt repayment, you get an extra $112 each month you could put toward a student loan that's hanging over your head. Or you could use the extra cash to build up an emergency fund. 

As a bonus, when you borrow with a HELOC, you get a few years to borrow, repay, and borrow more, up to your limit. (At Achieve, you get a five-year draw period, followed by a 10 to 30-year repayment period.) That’s a lot of flexibility to use your HELOC to reach even more financial goals if you choose to do so. 

2. Reduce the total amount of interest you pay

One way a HELOC could help you save is by reducing the total amount of interest you pay. Using the scenario outlined above, here's an example of how much you could save:

• If you didn’t consolidate the $20,000 in debt, but you kept paying $639 a month, you could pay a total of $9,200 or more in interest. 

• If you didn’t consolidate the $20,000 in debt and you only made minimum payments each month, you could pay $30,000 in interest.

• By consolidating the $20,000 debt, if you pay it off in the four-year time frame we mentioned above, you'll end up paying total interest of $5,280, saving you nearly $4,000.

Note that a lower interest rate may not save you money if you take longer to pay off the debt. 

Pro tip: Using a home equity loan for debt consolidation could save you thousands. 

3. Reduce the uncertainty of monthly payments

Most home equity loans offer a fixed interest rate and most home equity lines of credit (HELOCs) have variable interest rates. Achieve offers the best of both worlds in its fixed-rate HELOC for debt consolidation: the flexibility of a line of credit, and the stability of a fixed interest rate.

When you use a fixed-rate loan to consolidate credit card debt, your payments become more predictable. This is an important distinction, because with variable rates (like those on credit cards), your payments could fluctuate dramatically, depending on what's going on with the economy. (The payment amount on a HELOC could change during the draw period when you have the option to borrow, repay, and borrow more. Once you enter the repayment period, the payment amount on a fixed-rate HELOC will remain the same for the life of the loan.) 

Imagine you have multiple credit cards, each with a variable interest rate. In addition, assume those aren't the only variable-rate debts you're paying. Let’s say you also have a loan from the Small Business Administration (SBA) and a line of credit from your bank—both of which carry a variable rate. While you can currently afford the payments, you may be concerned about what could happen if interest rates begin to rise again and your variable rates increase. 

A fixed-rate HELOC could reduce the uncertainty of paying monthly bills because you know the interest rate won’t change. With a fixed monthly payment, it’s much easier to manage your budget.

4. Simplify your financial life

Say you have medical debt, credit card balances, a personal loan, and veterinarian bills that cropped up all at once. Sitting down to pay your monthly bills takes far longer than you’d like. You worry that one will slip through the cracks because the due dates fall throughout the month. You don’t want to stretch your budget even further to accommodate late fees. 

By consolidating debts using a HELOC, you could cut down on the number of bills to tend to each month. In short, you simplify bill-paying and carve out more time to do the things you'd rather be doing. 

5. Improve your credit standing

Your credit card balances, compared to your credit limits, have a dramatic effect on your credit standing. Having high balances could drag your credit score down, and having low balances could have a positive effect. 

We’re talking about credit utilization. For example, if you have a credit card account with a $10,000 spending limit and your balance is $9,000, your utilization is 90%. 

9,000 ÷ 10,000 = 0.90% 

You're free to use the entire $10,000, but creditors are likely to be concerned that you're getting in too deep. Your credit score will reflect that. Generally, the less available credit you use, the better it is for your credit score. Here's an example of how your credit card balances impact your credit utilization ratio:

By dividing $10,500 by $22,500 you can see that you have a credit utilization of 47%. 

People with the highest credit scores keep their utilization in the single digits. If yours is high, a good goal is 30% or less. 

Now, let’s say you get a home equity loan and use it to completely pay off those credit cards. Your utilization ratio drops to zero.

There is no guarantee of credit score improvement by obtaining a HELOC. Individual results vary.

6. Pay off existing debt—and focus on the future

It's pretty tough to focus on future goals, like moving or planning for retirement, when you're caught up in a cycle of high-interest debt. If you want to free up enough money to invest in the future, a wisely managed consolidation loan can help you get there. 

The trick is to pay off existing debt without allowing it to pile up again. Say you use your HELOC to pay off three credit cards, a personal loan, a large veterinarian bill, and some new living room furniture. Once the old debt is paid off, don't allow it to creep back up. It's fine to use a credit card, as long as you pay it off before the end of the billing cycle and you're never hit with interest. 

Finally, there's no way to overstate the importance of an emergency fund (also known as a life happens fund). Tucking a little away each month means you won't need to go into debt to pay for the next major unexpected expense. 

Getting rid of old debt through debt consolidation and having an emergency fund at your disposal are two great ways to actively prepare for the future.